Buying to Open vs. Selling to Open Options

Learn about the two basic types of options trades

   

Beginning options traders are generally familiar with “buying to open” calls and puts, but might not be so familiar with “selling to open,” says option trading information.

Buying to Open

When you buy to an option, you pay premium to initiate the trade and obtain the rights of the option. You’re now long either a call or put, and you benefit if the underlying equity moves beyond both your strike price and the options premium you paid. Generally, you’re buying volatility because you believe it’s underpriced.

To close that “buy to open” trade, you eventually “sell to close” the call or put. Buying calls and puts — and subsequently selling them to close out the position — is just like regular stock trading. You can buy a stock to open a position and sell the stock to close the position.

Selling to Open

“Selling to open” a call or put is called options writing. When you sell to open, you collect premium because you’re selling the rights of the option to another market participant. You’re now effectively short the call or put. You benefit if the underlying equity doesn’t move beyond your strike price. Generally, you’re selling volatility because you believe it’s overpriced.

To close those “sell to open” positions, you eventually “buy to close” the call or put. Selling to open a put is similar to shorting a stock. To close the short stock position, you’d buy the stock. To close the sold-to-open option position, you’d buy to close. Unlike shorting stock, you don’t borrow puts when you sell to open. You’re simply creating new derivatives on the underlying stock.

Selling to open a call carries theoretically unlimited risk. However, selling a call of a stock you already own is one way to generate extra income into your portfolio. This strategy is known as covered call writing. You collect premium when you sell to open a call, and your risk is mitigated because you already own the stock and will be able to deliver this stock if the call you sold is acted on.

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Article printed from InvestorPlace Media, http://investorplace.com/2010/09/buying-to-open-vs-selling-to-open-options/.

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